What kind of investment return should plans expect?

The most contentious debate in public pension circles right now is whether it's reasonable to assume investments can yield returns, averaged over 10 years, of at least 8 percent.

It's a key factor in whether pension funds can recover from the Great Recession because contribution amounts from employee paychecks and public employers are based on assumptions about what will happen in the future -- most notably stock market returns, which account for 70 percent of pension fund revenue.

Over the past decade, the return on Minnesota pension investments has averaged 7.7 percent, causing the plans' unfunded liabilities to more than double. Concerns prompted Minnesota lawmakers last year to reduce the state's investment return assumption from 8.

"There's an assumption that we'll make it up when the markets bounce back," said King Banaian, an economics professor at St. Cloud State University and a former state legislator. "Will that happen? Or are we in some 'new normal' where the returns you get from the stock market are lower than in previous years?

"I'm a 'new normal' believer ... and expecting an 8.5 percent return is not the majority opinion anymore.

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The executive directors of the state's pension systems -- Public Employee Retirement Association, Minnesota State Retirement System and the Teachers Retirement Association -- say dropping to 8 percent was a good idea, but they don't think it's wise to go lower because that would require taxpayers to pony up additional money to cover the costs. Then if the market does better than expected, the taxpayers would've paid too much. They look at the market on a 30- or 40-year horizon.

"I think there's too much attention paid to this," said Dave Bergstrom, executive director of the plan covering state employees. "What's more important is, do you want to have true changes, true savings?"

Only four large pension plans nationwide remain at an 8.5 percent investment return assumption. Two large plans in Indiana have dropped to 6.75. Most are between 7 and 8 percent, according to a report by the National Association of State Retirement Administrators.

"If we had gone with the most pessimistic view on investments, we would have had to immediately do a big chunk of extra contributions from (workers), but when you look at the 10-year period, we weren't really that far off," said state Rep. Phyllis Kahn, DFL-Minneapolis, a longtime member of the Legislative Commission on Pensions and Retirement.

Minnesota's assumed rate is slated to go back to 8.5 percent after 2017, but Kahn and others said the pension commission plans to review that each year.

Larry Martin, executive director of the pension commission, said one of the first items on the pension commission agenda this year will likely be a report on the investment return from the State Board of Investments, which handles investments for nearly all of the state's plans.

"We need to get either reassurance that what we heard a year ago is still true or get a new forecast of the investment horizon -- at least looking out at the next decade," Martin said.

Banaian said the hourlong debate in the Legislature last year about dropping from 8.5 percent to 8 percent felt like they were "arguing over relatively small numbers."

"We're in fact talking about billions of dollars," Banaian said. "When you compound that over 20 or 30 years, those small changes have huge impacts on our ability to pay that pension."

Barton Waring, a financial economist and pension expert, said the higher investment return assumption hides the fact that these promised benefits actually cost "two or three times what we've been telling ourselves."

"The politically easy way out is to go into more risky investments. That doesn't require a conversation about increasing contributions or reducing benefits," Waring said. "But is that the right thing to do when the plan is underfunded?"

Minnesota's historical record of getting 70 percent of its revenue from investments is a lot higher than plans in other states, fund leaders acknowledge. Minnesota's public employers have largely paid their contributions when they were due, making it possible for that money to earn interest.

"The good news is that the investment return lightens the load for taxpayers, but the bad news is that we're very dependent on the market," said Laurie Hacking, executive director of the Teachers Retirement Association.

Hacking doesn't want to rely on returns exceeding 8.5 percent to get back to an adequate funding level.